Geopolitical implications of the current economic downturn

There are several schools of economic thinking about the current down cycle of the US economy.

• The mainstream consensus of neo-Keynesian economics:  this is just another business cycle, to be treated with the usual tools.  To see this analysis, read today’s op-ed in the New York Times by Joseph E. Stiglitz.
• There are a few heretics, even some apostates.  The first question if the standard remedies of fiscal and monetary policy, plus devaluing the currency, will work this time.  The latter question the Keynesian paradigm itself.  Does it adequately consider the effect of rising debt levels?  Might the insights of Hyman Minsky show the limts to the operating boundaries of Keynesian theories?  Perhaps we need a fusion of Keynesian and Austrian economics?
• The members of the small Austrian school of economists, vocal but powerless to affect public policy.

What if the heretics and apostates — perhaps even the Austrians — are right, and this cycle is different?  Let us explore this scenario and see what it says about America’s geopolitical (esp. military) strength…

• The current economic downturn takes us beyond the envelope in which mainstream economic theory works.
• This marks the end of the post-WWII economic regime, during the last 25 years of which American public policy allowed massive growth of debt — to both foreign and domestic creditors — and deterioration of the competitiveness of US goods and services on world markets (i.e., decreased ability to pay our foreign debtors).

The key source of disharmony in the global economy is our foreign borrowing and weakening competitiveness.  Either would be bad; having both is deadly.

• These US policies have resulted in great distortions in global flows of capital and trade.  For example, a funneling of a large fraction of world savings to the US (we do not invest, but spend it), including the oddity of savers in the world’s poorest nations funding consumption by the world’s richest nation.
• The current economic slowdown marks the begging of the long-predicted “re-balancing” of the global economy, in which these oddities disappear and more normal patterns return.
• The global dominance of the US depends on massive borrowing at low interest rates from a small number of governments, most Asians and oil-exporters, with no thought as to how or when we will repay these loans.

The restoration of normal economic relations probably requires the value of the US dollar to decline far below levels seen since President Nixon took us off the gold standard in 1971 (sparking the great inflation of the 1970’s).  The greatest adjustment might be vs. the Chinese currency (the RMB or yuan), devaluing the USD/RMB by 1/3 to 1/2 (expert estimates vary widely).  

• That will make our exports of goods and services far more competitive, allowing us to earn the foreign currency needed to repay our creditors.
• That will make imports of raw materials (e.g., oil) and goods (e.g., toys and TV’s from China) far more expensive.
• The net result will be a greatly reduced US trade deficit, and less foreign borrowings.  The “outsourcing” of jobs to emerging nations will slow, as our workers become relatively more attractive for employers.  (Wages here would not crash to those of the 3rd world, as American workers and facilities are far more productive).

The UK went through a similar process starting after WWI and ending with the election of Margaret Thatcher as Prime Minister in 1979.  This is the decline and fall of the British Empire.  In 1900 their web of military bases encircled the globe.  As they grew poorer and the value of the pound fell, these bases became too expensive – an unaffordable luxury.  Since the locals were unwilling to pay for the police services provided by the UK, the bases closed and the troops went home. 

Now it is our turn.  

This adjustment in the US economy might have consequences other than reducing our ability to buy overseas bases and fund wars.  The stress on the economy might force reallocation — or even reductions — in federal spending.  Increased military spending — new generation of stealth aircraft and capital warships, a larger armies, permanent occupation of Iraq and Afghanistan, a “star wars” missile defense shield – might become a fantasy.  We could afford to spend 14% of GDP on defense during the Korean War, when our industries dominated the global economy.  We could almost afford to spend 10% on defense during the Vietnam War.  By massive government borrowing President Reagan could spend 7% on defense.  In the coming decade we might find spending 3% of GDP too much to bear.

The dreams of so many brilliant thinkers, from neocons like William Kristol to visionaries like Thomas Barnett, will become moot.  However desirable or feasible, we will no longer have the money to fund them.  They will find themselves trumped by the bleak forecasts of Paul Kennedy, author of Rise and Fall of the Great Powers (1987).

This does not mean the end of America.  America will outlast its empire.  We were a benign hegemon, perhaps the greatest hegemon in world history.  We gave much and asked little.  After victory in war we asked for no reparations; our enemies became our friends.  Our soldiers return from overseas duty with neither tribute nor loot.  The international order we created after WWII, both economic and geopolitical, saw the fastest growth in global wealth and income since the invention of agriculture.   Our dreams of global peace brought forth the United Nations.  Our dreams of exploration landed men on the moon.  We can look back in pride at our half-century of dominance.

Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

Other posts on this subject

A brief note on the US Dollar. Is this like August 1914?  — How the current situation is as unstable financially as was Europe geopolitically in early 1914.

The post-WWII geopolitical regime is dying. Chapter One  – Why the current geopolitical order is unstable, describing the policy choices that brought us here.

We have been warned. Death of the post-WWII geopolitical regime, Chapter II – A long list of the warnings we have ignored, from individual experts and major financial institutions (links included).

Power shifts from West to East: the end of the post-WWII regime in the news – We are seeing another western industry ceding dominance to eastern competitors, one more step in a larger process.

Death of the post-WWII geopolitical regime, III — death by debt – Origins of the long economic expansion from 1982 to 2006; why the down cycle will be so severe.

A recommendation to read these bulletins from the front! – A brief note on today’s articles in the NY Times and Financial Times, with Brad Setser’s explanation of why they are important.